Exemptions in Chapter 7 Bankruptcy

Chapter 7 bankruptcy exemptions protect property and ensure that filers aren't left destitute after bankruptcy. However, because not all property is protected, you likely want the answer to the question asked in all Chapter 7 bankruptcies, which is "What assets do you lose in Chapter 7?"

Fortunately, most people who file for Chapter 7 bankruptcy typically retain all or most of their assets, including essential items needed to maintain a household and a job. This article explains:

• What exemptions protect. Exemptions protect essential items, such as clothing, household goods, and a certain amount of equity in a home and car, as well as some retirement accounts and wages.
• How exemptions work in Chapter 7. If an exemption fully covers an item, you are allowed to keep it. If not, the trustee will sell it to pay creditors.
• State vs. federal exemptions. Your state decides whether you must use the state bankruptcy exemptions or whether you can choose the federal bankruptcy exemptions.

What Are Chapter 7 Bankruptcy Exemptions?

Bankruptcy exemptions are laws that give people the right to keep essential property from bankruptcy creditors. Typically, items considered necessary for living are protected by exemptions. Because most people don't own anything other than what would be considered basic items, bankruptcy filers often keep everything in Chapter 7. However, that isn't always the case. Valuable assets with significant equity, as well as luxury items, are rarely protected (nonexempt), and creditors share the sales proceeds of a filer's nonexempt property in Chapter 7.

Chapter 7 Bankruptcy: Exempt Assets You Can Keep

The assets you can keep in Chapter 7 include basic items, such as clothing, dishes, furnishings, and other household essentials. Also, bankruptcy exemptions typically protect some equity in a home and car, as well as certain retirement accounts and wages.

If you're wondering what assets you could lose in Chapter 7, you should be aware that bankruptcy exemptions don't cover exceptionally valuable items, and unnecessary things associated with entertainment or status. For instance, it would be unusual to keep an RV, expensive jewelry, or a timeshare in a Chapter 7 bankruptcy.

State vs. Federal Bankruptcy Exemptions

Your state determines whether you must use state-specific bankruptcy exemptions or if you can use the federal bankruptcy exemptions instead. Both systems allow you to retain a certain amount of equity in your home and personal property, such as a car, as well as certain retirement accounts and some wages. Also, no matter where you live, your household goods and clothing are usually exempt unless they're unusually valuable.

One of the benefits of the federal system is that filers who don't have home equity to protect can use the homestead exemption as a wildcard exemption to protect any property they choose. The federal exemptions work exceptionally well for those who want to retain luxury goods, cash, or investments, as relatively few states exempt these things.

How Chapter 7 Bankruptcy Exemptions Protect Property

When you file for Chapter 7, you list all your property in the bankruptcy paperwork, along with the value of each item, and the exemptions that apply. The Chapter 7 trustee responsible for your case will review the paperwork when looking for funds for creditors. The trustee can't recover an asset protected by an exemption. If an exemption fully covers an item, you get to keep it.

What If My Property Is Nonexempt?

If a bankruptcy exemption doesn't fully protect your property, it's at risk. The trustee has the right to recover or sell anything fully or partially nonexempt and use the proceeds to pay your unsecured creditors. Here's what happens.

The trustee will seize and liquidate the property, return any exemption amount to you (if the exemption didn't fully cover the property's value), and deduct sales costs and the trustee's fee. The trustee will use the remaining funds to pay unsecured debts, such as credit card balances, medical and utility bills, and outstanding rent or lease payments—even child support arrearages or taxes if the creditor doesn't have a lien against your property. Secured creditors, which are those with a property lien, like your mortgage or car loan lender, aren't paid out of these funds.

Exempting Cars, Homes, and Other Financed Property

In many cases, applying exemptions is simple. However, sometimes it can be more complicated, such as when a secured debt is involved, like a car payment or mortgage. In that case, the creditor's lien on the property must be paid first, followed by your exemption amount, sales costs, and the trustee's fee. Here's how it works.

Suppose your car is worth $15,000, your state has a $5,000 motor vehicle exemption, and you have an outstanding car loan of $5,000. The trustee must pay the lender $5,000, resulting in an equity balance of $10,000, your exemption amount, and more. It would look something like this:

• pay the lender $5,000
• pay you the $5,000 exemption amount
• pay sales costs and the trustee's fee out of the remaining $5,000, and
• distribute any remainder to other creditors.

The same analysis would apply to a home or other property with a lien on it. Additionally, it's essential to recognize that this analysis is limited to determining whether the trustee will seize property. You must meet additional requirements to prevent a lender from recovering the property.

You'll find more on these issues in Your Home in Chapter 7 Bankruptcy and Your Car in Chapter 7 Bankruptcy. More details are also below in the "Chapter 7 Exemption Q&As" section.

Does the Chapter 7 Trustee Always Sell Nonexempt Property?

No. The trustee won't put in the effort to sell the property unless it's likely to generate money for creditors, which isn't always the case. Sometimes, even a valuable asset isn't worth selling, in which case the trustee will release (abandon) the property, and you'll get to keep it.

Example. Henry, an avid gardener, filed for Chapter 7. He owned only native plants except for one exotic specimen that he was especially fond of, which was nonexempt and worth $2,500. However, the Chapter 7 trustee discovered that the only potential buyer already had that particular plant and wasn't interested in it. Given the lack of a market, the trustee abandoned the plant, and Henry was able to keep his prized possession.

Can I Buy Back My Nonexempt Property?

In most cases, yes. The purpose of exemption laws isn't to deprive you of property, but rather to strike a balance between your needs and creditor repayment. If you're willing to pay the amount creditors would receive had the property been sold, most trustees will accommodate you.

The discounted amount paid is typically 80% of the property's value, minus any exemption amount. The deduction takes into account the sales costs portion that the creditors wouldn't have received had the trustee sold the property.

One last point? You would need to use funds that are not part of the bankruptcy estate, like wages earned after filing or a loan from a friend or family member.

Example. When Pamela filed for Chapter 7, she couldn't exempt a surfboard that fellow pro surfers had signed during a championship tour. The trustee insisted on an appraisal. Because one of the signatures was by a surfer of legendary status, the appraiser set the value at $6,000. Because Pamela didn't want to lose it, she requested to buy it from the estate. The trustee agreed and sold it to her for $4,800, which was its value minus the estimated sales costs. The trustee even gave her two months to raise the funds.

Chapter 7 Exemption Q&As

Here you'll find additional exemption issues to consider, along with links to articles that will explain additional nuances and hurdles you might face when attempting to retain property in Chapter 7.

• Can I keep my financed car if I can exempt the equity?
• Can I keep my house if I can exempt all of its equity?
• What should I do if I discover that I forgot to list an asset in my bankruptcy petition?
• Can I use exemptions to protect property I've recently transferred to a friend or family member?
• Can I use exemptions to protect my tax refund?

Q. Can I keep my financed car if I can exempt the equity?

A. It depends on the value of your car, the amount of your loan, and your state's motor vehicle exemption amount. In a nutshell, you have two hurdles to overcome when property serves as collateral for a loan, not simply one. Not only must you protect the vehicle's equity with an exemption to prevent a trustee sale, but you must be current on the loan when you file to ensure the lender won't repossess it. Learn about keeping a car in Chapter 7 and how lenders obtain court permission to repossess during bankruptcy. Other issues to consider are whether you want to "reaffirm" the loan or save money by redeeming the vehicle and paying its value.

Q. Can I keep my house if I can exempt all of its equity?

A. It depends. Because a mortgage is a secured loan guaranteed by the home, the rules for keeping it are similar to those for vehicles (outlined above). Specifically, exempting home equity only stops the trustee from selling your home because it's only one of the requirements you must meet to keep your house in Chapter 7 bankruptcy. You might lose it if you're behind on the payment when you file. Learn more about what's required to keep a home in bankruptcy.

Q. What should I do if I discover that I forgot to list an asset in my bankruptcy petition?

A. Failing to disclose property in a bankruptcy petition is a type of bankruptcy fraud that can result in case dismissal, fines, and criminal charges. In most cases, the best course of action is to immediately inform the trustee of any forgotten property and amend your petition to reflect the property and the exemption law that protects it. If the property is nonexempt, the trustee is more likely to question the failure to list it. Consider consulting a bankruptcy lawyer for assistance.

Q. Can I use exemptions to protect property I've recently transferred to a friend or family member?

A. No, you can't because it isn't possible to exempt property owned by someone else. The more typical approach would be to retain ownership and exempt the property as you would other assets. Also, keep in mind that transferring property shortly before filing bankruptcy can be considered a "fraudulent transfer" by the bankruptcy court if you don't receive payment or if the payment is less than the property value. This type of strategic maneuvering raises red flags in bankruptcy cases.

Q. Can I use exemptions to protect my tax refund?

A. Whether you can exempt a tax refund depends on when you receive it relative to your bankruptcy filing and the specific exemption laws in your state or the federal system. For instance, suppose you become entitled to receive a refund for a tax year that ends after you file (it's essential to recognize the emphasis on when you become entitled to receive it, not when you physically receive it). In that case, the answer in a Chapter 7 case is clear. It's considered postbankruptcy income and not part of the estate.

By contrast, if you're owed a refund for a tax year that ended before you filed for Chapter 7, that refund becomes part of your bankruptcy estate. You can exempt a portion or all of it using available exemptions, such as a wildcard exemption or a specific state exemption for tax refunds or cash. However, because these exemptions are rare, you may need to pursue an alternative strategy.

Need More Bankruptcy Help?

Did you know Nolo has made the law accessible for over fifty years? It's true, and we wholeheartedly encourage research and learning. You can find many more helpful bankruptcy articles on Nolo's bankruptcy homepage. For instance, Nolo articles will explain what bankruptcy can do, what you'll want to avoid before filing for bankruptcy, and more. Information needed to complete the official downloadable bankruptcy forms is on the Department of Justice U.S. Trustee Program website.

However, online articles and resources can't address all bankruptcy issues and aren't written with the facts of your particular case in mind. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.